I have the Ethernet shield working on modified the modified Twitter code where each push button press on the shield will send my cell phone an SMS with text like "button press 1" , "button press 2"...The arduino twitter account is monitored by my regular one and sends text messages for that one only.http://www.youtube.com/watch?v=XMQldXmIj7c

Would it be possible to somehow reply via SMS with a single character and have the shield turn on an led?

You can tweet via SMS and send direct tweets to any account that follows you ("D account This is a direct message."). If your sketch monitors incoming direct messages you can then act on them any way you like.